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Monday, May 30, 2016

The semiconductor industry is a tough place to play, but the
semiconductor equipment industry is even worse, as the cycles swing even
higher and lower, and as the timing of orders is difficult to predict
(and can have huge impacts on the stocks in the meantime). What's more,
you're talking about an industry where the key customers are keenly
focused on trying to improve their own free cash flow, leading to a "do
more with less" philosophy with equipment than can pressure suppliers.

What's
the best defense? A good offense, or in this case, compelling
technology and products that offer end users real advantages in
throughput, production costs, and/or total cost of lifetime ownership. Rudolph Technologies (NYSE:RTEC)
is trying to bring new technology to areas like advanced packaging,
inspection, and metrology and use it to leverage real growth in new
packaging technologies and RF and MEMS production.

While I'm an owner of Ultratech (NASDAQ:UTEK),
a Rudolph competitor, I do think Rudolph's valuation is interesting.
Product acceptance/adoption, order timelines, underlying demand for
chips, and competition are all real issues (and difficult to forecast in
their own right), but I believe mid-single digit revenue growth over
the long term and peak margins in the mid-to-high 20%'s can justify a
fair value in the mid-to-high teens today, with upside into the $20s if
things go well.

I think it is fair to say that Manitex (NASDAQ:MNTX)
was too ambitious and too aggressive when breakneck North American
onshore energy expansion fueled an unsustainable demand for cranes.
Management significant stretched the balance sheet in the interests of
empire-building, expanding into non-core areas like trailers and liquid
storage tanks. When the cycle turned, Manitex found itself with a lot of
debt, not a lot demand, and questionable synergies between the units.

All of that can certainly explain why the stock has been hammered worse than other lifting equipment companies like Terex (NYSE:TEX), Manitowoc (NYSE:MTW), Manitou, and Palfinger
since 2014, but it doesn't necessarily make the shares untouchable now
for aggressive investors. Management has pivoted from a
growth-by-acquisition model to more of a value-creation model, with a
stronger focus now on cost control/reduction, cash flow generation, and
sustainable growth in high-potential businesses like knuckle cranes and
the ASV product line.

I'm not as bullish on a meaningful rebound
in the North American energy market as I once was, but I don't think it
will much worse and I think construction (residential, commercial, and
civil) can be a driver for this business. I don't see Manitex struggling
to pay its interest, and I do believe further debt reduction efforts
can unlock some value. My current estimates call for long-term revenue
growth in the mid single-digits and peak FCF margins in the mid-to-high
single-digits, supporting a fair value of $7.50 that could go higher
if/when energy really recovers and/or management shows that it can build
its knuckle crane and ASV operations into disruptive players.

A lot has changed for PRA Group (NASDAQ:PRAA)
over the last few years. The company has become one of the largest
collectors of defaulted credit card receivables at a time when supply
has been reduced by the absence of three of the largest sellers of
charged-off receivables. The company has also seen a decidedly harsher
regulatory environment, as new rules and ample uncertainties have
dramatically changed how lenders approach the sale of charged-off
receivables and how operators like PRA Group and Encore Capital (NASDAQ:ECPG) can go about collecting them.

The
net effect to PRA Group has been a marked decline in reported profits,
cash flow, return on equity, and forward growth expectations. Whereas
management once boldly projected 20% ROEs into the future, the market is
now pricing in a long-term ROE closer to 14% and management's own
projections call for a mid-single digit GAAP growth rate without a more
conducive operating environment. While I think PRA Group remains
undervalued, my expectations have shrunk significantly, and there are
outsized execution risks both for getting the U.S. business back on
track and getting real value out of the increasingly expensive-looking
move into Europe. There may yet be value here, but this is another
example of trying to make money the hard way.

What do you do with a company that isn't growing anywhere near fast
enough to be a growth stock, doesn't have the margins or cash flow to be
a value stock, but has enough innovation and market potential to still
be a disruptive factor in the industry? Unfortunately for Accuray's (NASDAQ:ARAY)
shareholders, while the company has definitely been making progress,
the pace of that progress keeps it stuck in an underwhelming valuation
range, and there are still considerable doubts about whether it can take
the sizable step forward it needs to be a long-term viable third player
in its market.

I continue to approach
Accuray with what I consider to be optimistic skepticism. I think the
company has good technology and has really been focusing on addressing
the past and current deficiencies of its systems. That said, this is a
slow-growing market with a huge entrenched competitor and it is far from
clear whether Accuray can establish a big enough market share footprint
to drive the margins it needs to create long-term shareholder value. I
think a fair value around $7.50 to $8.50 is fair today, with underlying
upside if the company can demonstrate its ability to get and hold a
double-digit market share before 2020.

Monday, May 23, 2016

I want to apologize again for those who come to this page on a regular basis - I've been horrible about posting timely updates. I don't want to make excuses for this, but the "why" basically comes down to the fact that I was in the habit of making updates at night, and now my nights are a lot busier taking care of various errands and chores. But I'm going to try to be better about it.

When I last wrote about BRF S.A. (NYSE:BRFS),
I warned that investors were likely in for a bout of elevated
volatility - a prediction that, when made in reference to almost any
Brazilian company, is a little like predicting that jumping into the
ocean will make you wet. The shares have indeed jumped around since that
last article and the shares have underperformed not only the Bovespa,
but other Brazilian food players like Marfrig (OTCPK:MRRTY), JBS (OTCQX:JBSAY), and Minerva (OTCQX:MRVSY).

Whether
BRF shares are a good idea now rests in large part on your time
horizon. The company is doing a lot of smart things - relaunching a
complementary value-priced brand in Brazil, prioritizing higher-margin
processed/packaged foods, and using M&A to acquire local production
and distribution to capture more value from international sales. Along
the way, though, there have been frequent management shake-ups and there
is still a lot of volatility in the business model due to commodity
inputs, protein prices, currency, and so on.

I do believe that BRF can eventually achieve its goals of becoming more like Hormel (NYSE:HRL) or Nestle (OTCPK:NSRGY)
and achieving EBITDA margins in the high teens or even 20%, and I do
like the company's efforts to improve ROIC in recent years. That said,
getting volume growth going again is a clear must-do and investors can
certainly be forgiven for thinking that BRF is too risky and too
volatile to mess with today. I believe the fair value for the ADRs is
still above $17, but it's going to take a healthier, or at least more
stable, environment in Brazil for these shares to do meaningfully
better.

These aren't easy times for biotech, but that's not exactly news to investors in that sector. Neurocrine Biosciences (NASDAQ:NBIX) has gotten caught up in the sector-wide funk, though the shares have declined less since my last update than the biotech indices.

Neurocrine
still looks promising to me. There are significant uncertainties about
potential pricing for the company's lead drugs, not to mention the
amount of effort that will have to go into building prescription-driving
awareness. That said, this is still a company with multiple compounds
with $1 billion-plus revenue potential that have largely proven their
efficacy and safety in clinical trials. With the shares possibly
undervalued by 50% or more, I would suggest this is still a worthwhile
stock to consider for aggressive investors willing to put up with the
risks and long waits that go with biotech.

Microsemi Corp. (NASDAQ:MSCC) hasn't done that well since my last update
on the company. While the shares were at least up in that intervening
period, they've underperformed the PHLX Semiconductor Index by a little
and particular names like Texas Instruments (NASDAQ:TXN), Semtech Corp. (NASDAQ:SMTC), and Silicon Labs (NASDAQ:SLAB)
by a whole lot more. To a limited extent, maybe this is just "Microsemi
being Microsemi" - I've owned and/or followed this name for a long
time, and it always seems to zig when others zag. On the other hand,
investors may be legitimately concerned about the level of debt the
company has to manage now as well as the uncertainties regarding
revenue, margins, and cash flows as the company moves through its
initial stages of integrating PMC-Sierra.

My post-earnings model
adjustments lead to a lower fair value, which is bad, but I still
believe the shares are undervaluing what can be a strong mid-teens FCF
growth story for many years to come. With a fair value range from the
high $30s to the low $40s, I still think these shares offer enough
upside for investors to consider.

It may be good advice to not look a gift horse in the mouth, but it's
also a pretty good idea to not get overly excited about unreliable
financial performance drivers. I'm still generally bullish on Denmark's H. Lundbeck A/S (OTCPK:HLUYY,
LUN.CO) (or "Lundbeck"), but my enthusiasm is tempered by revenue beats
that are coming largely from declining businesses, difficult marketing
environments for key drugs, and a pipeline that may be hard-pressed to
drive a lot of near-term pop.

I want to make it clear that I'm
talking about the difference between tapping the brakes and diving out
of the car entirely. I still think Lundbeck is a worthwhile idea as a
long-term holding, but I think the sentiment has shifted from unduly (if
not absurdly) negative a year or so ago to perhaps a little too
positive in the near term. I still believe $38-42 is a reasonable fair
value range for the ADRs, with potential upside from high-risk clinical
programs where the value is presently heavily discounted, but I'm a
little less excited about the near-term outperformance potential from
the core drug business.

Ultratech (NASDAQ:UTEK) is never going to be Honeywell (NYSE:HON) or Coca-Cola (NYSE:KO),
so if you're looking for a consistent, predictable company without a
lot of quarter-to-quarter surprises, please look elsewhere. What
Ultratech does offer, though, is leverage to what looks like an
improving semiconductor order cycle, as well as leverage to specific
drivers like advanced packaging for logic chips, 3D metrology, and
perhaps the ongoing move to smaller FinFET nodes.

These shares have done pretty well since my last write-up, with Ultratech's roughly 20% move ahead of the SOX Index (up about 12%), though not as strong as the 25% move at Applied Materials (NASDAQ:AMAT) and Rudolph (NYSE:RTEC).
Valuation remains tricky; if the company could regain the 20%-plus
operating margins and 15%-plus FCF margins of prior upswings, there
would still be upside, but UTEK faces a lot of competition in its key
markets, and there are legitimate questions about its ability to
execute.

Sunday, May 15, 2016

Wall Street hates uncertainty and there are still a lot of unknowns at Wright Medical (NASDAQ:WMGI).
The full cost of the company's hip litigation has yet to be determined
and there are still outstanding questions regarding the adoption of the
Augment biologic product, competition from the likes of Stryker (NYSE:SYK),
and management's ability to successfully integrate Tornier and become a
strong extremity-focused specialty orthopedics company.

Good
performance can help ease some of those concerns, and Wright Medical's
first quarter results were good. There's still an above-average level of
skepticism regarding smaller med-tech in the market, and that keeps
Wright Medical shares priced at a discount. Given the growth prospects
for the existing product portfolio and the opportunities to leverage
further product development, these shares are worth a look from more
aggressive investors.

In some respects, Commercial Vehicle Group (NASDAQ:CVGI)
is seeing results from its protracted turnaround attempts - the
company's gross margins have improved, there is a credible plan in place
to reduce operating costs further, and management seems to be well
aware of the need to carefully manage its manufacturing footprint to
preserve margins. On the other hand, 2016 is likely to be a horrible
year for Class 8 truck orders (and particularly the linehaul trucks that
offer the most content and best margins), and the company's
long-standing efforts to diversify into off-highway markets still
haven't borne much fruit.

Although I think Commercial Vehicle's shares remain undervalued on the basis of the cash flows that the company can generate, I don't know how anyone could have a lot of confidence regarding the likelihood that it will
generate those cash flows - and a significant industry down-cycle is
not often the time to take big swings on risky ideas. So while I do
suggest that investors looking for risky deep-value turnarounds
could/should dig into this story, and I will continue to hold on to my
tiny position, this is most definitely an example of trying to generate
alpha the hard way (something that, in keeping with my sloth-like
torpor, I generally avoid).

Years of disappointment and misleading guidance from prior management put Lexicon Pharmaceuticals (NASDAQ:LXRX)
in a deep hole with respect to Street sentiment, but the company's
execution is helping it slowly dig its way out. This year (2016) should
see the company get its first product approved by the FDA, as well as
key pivotal data on the Type 1 diabetes program.

While I'd
certainly count myself in the camp of "long-suffering investors", I'm
still generally more bullish on Lexicon than the sell-side. I believe
sales of the company's lead drug telotristat etiprate can total more
than $500 million at peak, supporting a fair value above today's price
on its own. There's considerably more room for debate about the
potential (and potential value) of Lexicon's Sanofi-partnered (NYSE:SNY)
diabetes program, not to mention Lexicon's future R&D development
plans, but these shares look like a risky play with an interesting skew
to outsized potential gains.

Sunday, May 1, 2016

It is hard to argue that Semtech (NASDAQ:SMTC)
has historically served its investors particularly well. The 10-year
performance of the stock (up about 25%) lags not only the PHLX Semiconductor Index by a meaningful amount (the SOX is up more than 70% over the past decade) and the Nasdaq, but other chip companies like Microsemi (NASDAQ:MSCC), Integrated Device Technology (NASDAQ:IDTI), and Texas Instruments (NASDAQ:TXN), and the five-year comps are even worse.

What's more, the internal value creation isn't impressive at first
blush either, with tangible book value per share down almost 75% since
2007 (a CAGR of around negative 13%). Gross margins have been generally
healthy over that time and free cash flow has always been positive, but
metrics like operating margin and ROIC are less exciting.

I'm not looking to bury Semtech, as I do think the company's
technology for enterprise datacenters, wireless communication, sensors,
and power management can grow the business. Moreover, there would seem
to be opportunities to improve operating leverage through tighter
management of SG&A and R&D expenses.

When it's all said and done, though, I believe the semiconductor
industry is transitioning away from a valuation philosophy of "as long
as you grow, it's all fine" to one more centered around margins and
value creation. With that, I believe it is very important for Semtech to
not only show solid revenue growth trends, but also that it can
translate that growth into long-term shareholder value.

The past couple of years have been rough ones for the steel sector,
but stock prices have improved pretty noticeably in recent months on
optimism that improving conditions in the market aren't yet another
false start for the long-predicted recovery. Relatively speaking, Commercial Metals (NYSE:CMC) has held up all right - the shares haven't been as strong as those of Steel Dynamics (NASDAQ:STLD), but they've done quite a bit better than those of Gerdau (NYSE:GGB) and U.S. Steel (NYSE:X), while also outperforming AK Steel (NYSE:AKS) and Nucor (NYSE:NUE) over the past year.

Can they keep it going? This fiscal year should be the low point of
the current cycle and the outlook for non-residential construction is
still positive, but there's a lot of capacity out there, the dollar is
still pretty strong, and competition from imports (Turkey in particular
in the case of Commercial Metals) is still a risk. Although the rally in
the shares makes it harder to call them a bargain today, it's worth
remembering that cyclical recoveries are a lot like the declines - they
tend to go further, faster, than you might initially think.

It's been a while since I've written on Helen Of Troy (NASDAQ:HELE).
While I've long liked the company's growth-by-acquisition strategy in
the consumer goods space, I wasn't a fan of former management and that
relegated it to my "I'll never buy it, so why bother?" bucket. Better
management has been in place for about two years now, though, and I
think the company's underlying strategy is stronger.

The trouble for me, as is so often the case, is with the valuation. I
have no problem acknowledging that Helen of Troy should be valued
beyond its organic growth capacity (likely low-single digits on revenue,
mid-single digits on cash flow), as the company generates free cash
flow and rolls that into acquisitions that grow the business and
generates more cash flow (which, in turn, can be reinvested back into
acquisitions...). Likewise, it doesn't bother me that much that tangible
book value is negligible given all of the goodwill and intangibles from
the deals.

The problem is that even if I assume significant improved free cash
flow margins in the future (in the low teens), it will take around 8% to
10% annual revenue growth to support a fair value at or above $110 and
that seems ambitious. Likewise, such a fair value requires a mid-teens
forward EBITDA multiple and I just don't think that's particularly
attractive given what I expect will be high single-digit annualized
EBITDA growth over the next three to five years.

I don't criticize a company like Grainger (NYSE:GWW)
(or "W.W. Grainger") lightly. You don't get to be the second-largest
MRO distributor in the country by accident, nor are many years of 20% or
near-20% ROICs the sort of results that a company just blunders into by
accident. What's more, Grainger is very well-diversified across
customer and product types, with room to take share and add incremental
product categories.

All of that said, I can't get comfortable with the valuation or the
strategic direction. It seems to me that Grainger has either not been
really thinking through some of its growth initiatives over the past few
years or has shown a startlingly low amount of patience with them.
Moreover, for Grainger to look cheap in my models there either has to be
double-digit annualized FCF growth from here or a lower discount rate
that I just frankly wouldn't find acceptable for a cyclically-exposed
company in a highly competitive space.

ABB (NYSE:ABB)
didn't report a great quarter in many respects, but the overall
performance of this Swiss automation and power equipment giant was
pretty solid against a rough backdrop. Although it looks like the first
quarter reports from the industrial sector will deflate some of the more
bullish expectations for a sharp recovery during 2016, it also looks as
though the doomsday scenario isn't as valid as it was back in January
(when many of these stocks hit their lows).

Given the solid rebound off those lows, ABB looks like an okay stock idea. The performance of Honeywell (NYSE:HON), Rockwell (NYSE:ROK), and Emerson (NYSE:EMR) has reduced the attractiveness of those stocks as well, though, and ABB does look like more of a relative bargain.

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I started this blog as a way of archiving my writing for sites like Investopedia, as well as posting some thoughts on the markets, stocks, or whatever else strikes my fancy.
Feel free to email me.
You can reach me at tuonela (dot) fool (at) gmail (dot) com

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This blog represents the opinions and views of its author.

Information is taken from sources believed to be reliable but no warranty or guarantee is made with respect to accuracy.

Investing involves risk and requires proper due diligence. In no way should a reader should presume this blog represents personalized financial advice or is a substitute for proper due diligence. The author expects you to be enough of a grown-up to realize this.